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September 3, 2014

Beware of ‘Cliff’ in New York’s New Estate Tax Law

Wilmington Trust’s Sharon Klein considers some implications of the new state law

While some of the estate tax amendents are positive for heirs, one in particular lurks at the edges.

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New York State’s Department of Taxation and Finance last week released a summary of amendments to New York’s estate tax that became effective April 1 with the enactment of the 2014–15 Executive Budget.

Sharon Klein, managing director of family offices services and wealth strategies at Wilmington Trust, said in an email memo that the summary included some clarifications of language in the budget. She also pointed out the implications, one bad one, of several amendments.

Gross Estate Increase

The budget increased a resident decedent’s New York gross estate by the amount of any taxable gifts made within three years of death.

A decedent’s New York gross estate means his or her federal gross estate, whether or not a return is required, according to the summary.

Klein noted that the summary made clearer than had the budget that gifts were not added to the gross estate if they consisted of real or tangible property located outside New York, of if a gift was made when the decedent was a nonresident before April 1, 2014, or on or after Jan. 1, 2019.

The new law says that the estates of residents who died after April 1 must file a New York State estate tax return if the federal gross estate — increased by the amount of any gifts includible in the New York gross estate — exceeds the basic exclusion amount applicable to the date of death.

New York taxable estates of individuals who were nonresidents at the time of death will be computed in the same way as those of residents, with these exceptions:

It will not include intangible personal property that would otherwise be includible in a decedent’s New York gross estate.

It will not include any otherwise includible gift in the New York gross estate unless that gift was made while the nonresident individual was living in New York and it consisted of real or tangible personal property located in the state or intangible personal property used in a business, trade or profession carried on in the state.

Estate Tax ‘Cliff’

In her memo, Klein said that under the new law, the New York estate tax computation contained a dangerous estate tax “cliff.”

Estates that are less than or equal to the New York estate tax exclusion amount will pay no tax.

However, the credit for New York taxable estates that are between 100% and 105% of the basic exclusion amount is rapidly phased out, and is eliminated entirely if the New York taxable estate exceeds 105% of the basic exclusion amount.

This means that “if a resident decedent’s taxable estate exceeds the basic exclusion amount by more than 5%, the entire taxable estate will be to be subject to New York estate tax,” Klein said.

The summary presents examples that illustrate the operation of the credit for an estate that is less than the basic $2,062,500 exclusion amount for April 1 to March 31, 2015, and for an estate that exceeds the basic exclusion amount by less than 5%.

Example 1: A taxable estate of $1,525,120 will pay no tax because the taxable estate is less than the basic exclusion amount. The applicable credit equals the amount of the tax.

Example 2: A taxable estate of $2,100,000 exceeds the basic exclusion amount by less than 5%, and is subject to a credit phase-out. The applicable credit is less than the estate tax due, resulting in a tax liability of $49,308.

Klein said that these two examples did not spell out the dramatic effect of the cliff.

In the first example, a taxable estate of $2,062,500, the current exclusion amount, would also have paid no tax. In the second example, a $2,100,000 estate would have a $49,308 tax liability. The tax liability exceeds the increase in value from $2,062,500 to $2,100,000 — $37,500.

Also left unstated, Klein said, was the dramatic tax liability if the hypothetical estate were to exceed 105% of the basic exclusion amount.

An estate of, say, $2,165,650 would have an estate tax liability of $112,052. The increased tax liability for this estate over the $2,100,000 one is $62,744 ($112,052 – $49,308).

This bigger tax liability approximates the increase in value of the estate from $2,100,000 to $2,165,500—$$65,650. “The increase in the value of the estate is almost entirely eaten up by taxes,” Klein said.

When Federal Filing Is ‘Required’

Under the law, elections made or waived on the federal estate tax return are binding on a New York estate tax return. If a federal estate tax return is not “required to be filed,” certain elections can be made for New York purposes alone.

Klein said examples would be a separate state qualified terminable interest property (QTIP) trust election, or an alternate valuation election if this would decrease the value of the estate and the tax.

She said a question has arisen whether a federal return filed solely to elect portability (i.e., the estate is under the federal filing threshold) is “required” to be filed, thus foreclosing the possibility of certain separate state tax elections.

“This is particularly important where a fiduciary may be conflicted as to whether to make a separate state QTIP election or elect portability.”

The summary says that a federal estate tax return is considered required to be filed when a decedent’s gross estate exceeds the federal filing threshold, “and also when the federal return is the only means for claiming certain tax treatment (e.g., such as claiming portability of a deceased spouse’s unified credit for federal purposes).”

The summary reiterates that for New York State purposes, there is no portability.